HFTs to tap European equity options via OTFs

High-frequency trading strategies are set to penetrate the European equity option market, according to research from consultancy TABB Group.

In a report released today, the research firm said increased competition, new regulation and recent exchange consolidation had improved conditions for the automated trading of equity options in Europe.

As MiFID II, due to be issued by the European Commission next month, paves the way for the introduction of organised trading facilities (OTFs), TABB Group said these new entities were expected to serve as new, easy points-of-entry for high-frequency liquidity providers, bringing growth in trade volumes and tighter bid/ask spreads.

US listed options volumes have grown at a compound annual growth rate (CAGR) of 20% since 2002. However, Europe's listed options market grew at CAGR of 5% in the same period as institutional and hedge fund equity option order flow stayed away from exchange trading, said Will Rhode, a senior analyst at TABB Group Europe in London.

TABB claimed this was why only 26% of notional turnover of European single-stock options were traded on exchanges in 2010.

Other obstacles so far limiting market transformation included a fragmented inter-dealer broker landscape, the predominance of vertical clearing silos, and a lack of product fungibility, Rhode said.

“But the process of change has already begun. Many of the traditional boundaries are being tested, if not breached,” he said. “The speed with which change will occur is likely to only accelerate.”

The proposed Eurex/Liffe merger – currently subject to regulatory approval as part of the European Commission's review of Deutsche Börse's proposed combination with NYSE Euronext – could unite the two largest equity derivatives markets in Europe, bringing concentrated liquidity, cross-margining and netting into a single marketplace.

Whether trading occurred on OTFs, multilateral trading facilities, single-dealer platforms, multi-dealer platforms or an exchange, Rhode said the days of manual dominance were coming to a close in Europe.

“With the advent of more electronic trading platforms will come new market participants, like high-frequency liquidity providers with the power to make Europe's equity options markets deeper, more competitive, more tightly priced and far faster than ever before,” he said.

However, with a comparatively smaller choice of European equities options available, European institutional investors represented an attractive pool of demand for US-listed equity options, according to Andy Nybo, head of derivatives at TABB Group.

European investors currently account for an estimated 10% of total US-listed options trading volume. However, their high levels of assets under management offered significant room for expansion, according to the research firm.

“European-based investors are active users of index and single-stock options but they are exploring how to expand trading activity in exchange-trading funds, volatility and weekly option products,” said Nybo.

“More aggressive trading strategies deployed by hedge funds will drive short-term growth in European activity but greater demand from asset managers and private wealth accounts will add to volumes over time.”